Presented by: Group 9 Pinongpong, Alfe Geromo, Mary Jane Esic, Jenneliza Mae Lagran, lvy(CCC) — also known as the cash cycle — is a metric expressing how many days it takes a company to convert the cash it spends on inventory back into cash by selling its product. The shorter a company's CCC, the less time it has money tied up in accounts receivable and inventory.a i The Cash Conversion Cycle ® Short-term financial management—managing current assets and current liabilities is one of the financial manager’s most important and time-consuming activities. ® Central to short-term financial management is an understanding of the firm’s cash conversion cycle.Cash Conversion Cycle ®lnventory turnover ratio (IT): IT= Cost of Goods _ GI, 924 Inventory ~~ 37,009 =3.56 365 _ 365 Inventory Days = —— = —— = 102 days sey IT 3.56 :a i. Cash Conversion Cycle ™ Accounts receivable turnover (ART): ART= Sales _ 169,565 _ = 9.05 Acct.Rec. 18,735 AverageCollection Period = ae = ce =40 days ART 9.05a as Cash Conversion Cycle ™ Accounts payable turnover (APT): _ Costof Goods _ 131,924 APT=———_ = Accts.Payable 5,448 = 24.22 . 365 365 Average Payment Period = —— = —— = 15 days J APT 2422.”i cc Calculating the Cash Conversion Cycle ™ Both the OC and CCC may be computed as shown below. "OC = Inventory Days + ACP = OC = 102 + 40 = 142 days “CCC = OC — Average Payment Period = CCC = 142 —- 15 = 127 daysCash Conversion Cycle Chromcraft Revington’s Operating Cycle ‘Average Collection ‘Average Age of Inventory (AAI) | Period (ACP) | o BS z ss Daysa a Problem # 1 American Products is concerned about managing cash efficiently. On the average , inventories have an age of 90 days and account receivable are collected in 60 days . Accounts payable are paid approximately 30 days after they arise. © Operating cyele (OC) = Average age of inventories + Average collection period = 90 days + 60 days = 150 days = Cash Conversion Cyele (CCC) = Operating cycle — Average payment period = 150 days ~ 30 days = 120 daysFunding Requirements of the CCC = Permanent vs. Seasonal Funding Needs If a firm's sales are constant, then its investment in operating assets should also be constant, and the firm will have only a permanent funding requirement. If sales are cyclical, then investment in operating assets will vary over time, leading to the need for seasonal funding requirements in addition to the permanent funding requirements for its minimum investment in operating assets.fA _ TT Strategies for Managing the CCC 4. Turn over inventory as quickly as possible without stock outs that result in lost sales. 2. Collect accounts receivable as quickly as possible without losing sales from high- pressure collection techniques. 3. Manage, mail, processing, and clearing time to reduce them when collecting from customers and to increase them when paying suppliers. 4. Pay accounts payable as slowly as possible without damaging the firm’s credit rating.i TTT Inventory Management: Inventory Fundamentals ™ Classification of inventories: Raw materials: items purchased for use in the manufacture of a finished product 'Work-in-progress: all items that are currently in production Finished goods: items that have been produced but not yet soldi 0 Inventory Management: Differing Views About Inventory = The different departments within a firm (finance, production, marketing, etc.) often have differing views about what is an “appropriate” level of inventory. ® Financial managers would like to keep inventory levels low to ensure that funds are wisely invested. = Marketing managers would like to keep inventory levels high to ensure orders could be quickly filled. = Manufacturing managers would like to keep raw materials levels high to avoid production delays and to make larger, more economical production runs.Techniques for Managing Inventory = The ABC System The ABC system of inventory management divides inventory into three groups of descending order of importance based on the dollar amount invested in each. A typical system would contain, group A would consist of 20% of the items worth 80% of the total dollar value; group B would consist of the next largest investment, and so on. Control of the A items would intensive because of the high dollar investment involved.a cc Techniques for Managing Inventory (cont.) = The Economic Order Quantity (EOQ) Model EOQ = Pxsxo Cc = Where: S = usage in units per period (year) O = order cost per order C = carrying costs per unit per period (year) Q = order quantity in unitsTechniques for Managing WOMEN (cont.) Assume that KJB, Inc. uses 200 units of an item annually. Its order cost is $25 per order, and the carrying cost is $1 per unit per year. Substituting into the above equation we get: E0Q = praoousea = 100 $1 The EOQQ can be used to evaluate the total cost of inventory as shown on the following slides.i Ce Techniques for Managing Inventory (cont.) The Economic Order Quantity (EOQ) Model Ordering Costs = Cost/Order x # of Orders/Year Ordering Costs = $25x2=$50 Carrying Costs = Carrying Costs/Year x Order Size 2 Carrying Costs = ($1 x 100)/2 = $50 Total Costs = Ordering Costs + Carrying Costs Total Costs = $50 + $50 = $100_- ee Techniques for Managing Inventory (cont.) = The Reorder Point [ Once a company has calculated its EOQ, it must determine when it should place its orders. " More specifically, the reorder point must consider the lead time needed to place and receive orders. “ If we assume that inventory is used at a constant rate throughout the year (no seasonality), the reorder point can be determined by using the following equation: Reorder point = lead time in days x daily usage Daily usage = Annual usage/360: Techniques for Managing Inventory (cont.) Using the KJB example above, if they know that it requires 5 days to place and receive an order, and the annual usage is 200 units per year, the reorder point can be determined as follows: Daily usage = 200/360 = 0.56 units/day Reorder point = 5 x 0.56 = 2.78 or 3 units Thus, when RIB's inventory level reaches 3 units, it should place an order for 100 units. However, if RIB wishes to maintain safety stock to protect against stock outs, they would order before inventory reached 3 units.Techniques for Managing Inventory (cont.) = Just-In-Time (JIT) System The JIT inventory management system minimizes the inventory investment by having material inputs arrive exactly at the time they are needed for production. For a JIT system to work, extensive coordination must exist between the firm, its suppliers, and shipping companies to ensure that material inputs arrive on time. In addition, the inputs must be of near perfect quality and consistency given the absence of safety stock.i OTT Techniques for Managing Inventory (cont.) ™ Computerized Systems for Resource Control MRP systems are used to determine what to order, when to order, and what priorities to assign to ordering materials. CMRP uses EQQ concepts to determine how much to order using computer software. It simulates each product's bill of materials structure all of the product's parts), inventory status, and manufacturing process.Fs a Accounts Receivable Management = The second component of the cash conversion cycle is the average collection period — the average length of time from a sale on credit until the payment becomes usable funds to the firm. = The collection period consists of two parts: © the time period from the sale until the customer mails payment, and the time from when the payment is mailed until the firm collects funds in its bank account.Zl I — Accounts Receivable Management: The Five Cs of Credit ®™ Character: The applicant's record of meeting past obligations. = Capacity: The applicant's ability to repay the requested credit. = Capital: The applicant's debt relative to equity. = Collateral: The amount of assets the applicant has available for use in securing the credit. ® Conditions: Current general and industry- specific economic conditions.i I — Accounts Receivable Management: Credit Scoring = Credit scoring is a procedure resulting in a score that measures an applicant's overall credit strength, derived as a weighted-average of scores of various credit characteristics. = The procedure results in a score that measures the applicant's overall credit strength, and the score is used to make the accept/reject decision for granting the applicant credit.Z OTT Accounts Receivable Management: Changing Credit Standards = The firm sometimes will contemplate changing its credit standards to improve its returns and generate greater value for its owners. Effects of Relaxation of Credit Standards. Variable Direction of change _Effect on profits Sales volume Increase Positive Investment in accounts receivable Increase Negative Bad-debt expenses Increase Negativefl a Changing Credit Terms = A firm’s credit terms specify the repayment terms required of all of its credit customers. = Credit terms are composed of three parts: The cash discount The cash discount period “ The credit period = For example, with credit terms of 2/10 net 30, the discount is 2%, the discount period is 10 days, and the credit period is 30 days.ra a Credit Monitoring = Credit monitoring is the ongoing review of a firm’s accounts receivable to determine whether customers are paying according to the stated credit terms. = Slow payments are costly to a firm because they lengthen the average collection period and increase the firm's investment in accounts receivable. = Two frequently used techniques for credit monitoring are the average collection period and aging of accounts receivable.a a Credit Monitoring: Average Collection Period = The average collection period is the average number of days that credit sales are outstanding and has two parts: The time from sale until the customer places the payment in the mail, and The time to receive, process, and collect payment.Credit Monitoring: Collection Policy = The firm's collection policy is its procedures for collecting a firm’s accounts receivable when they are due. = The effectiveness of this policy can be partly evaluated by evaluating at the level of bad expenses. ™ As seen in the previous examples, this level depends not only on collection policy but also on the firm’s credit policy.= ST Collection Policy Popular Collection Techniques Technique Isil description Leters After a cerrain number of days, rhe firm ends a polite lerter reminding the customer of the overdue account. If the account is rot paid within s certain perio! ter hi lerter has Been sent, ‘second more densanding keri ent, ‘Telephonecally —_IFleters prove unsuccessal, elephone call may be mde to the ‘customer to rogue immediate payment M the customer has a ‘reasonable excuse, arrangements may be made toextend the payment period, (call from the sellers attorney may be sed. Personal visits “This tchnique i» much more common atthe consumer ert level, tr itmay also be eecrively employed by industrial supplier. Sending. focal salesperson ofa collection peeson to confront the “customer san be very effective, Payment may be made-on the spot. Collection agencies A firm ein sur uncolctible accounts ove 4 a collection agency 16 a attoency foe collection, The fees for this aevice are typically ‘wie igh the firm may receive fess than $@ cents on the dollar from accounts collet in this way. Legal accion Legal action inthe mose stringent step, an alternative ro the we of ‘callection agency. Nor only ts ditect legal action expensive, but iemay force the debtor into hankeruptey without jearameei the imate receipe of the overdue amou “The tebiques a isd ithe one in which sey ae ype followed inthe cllecionprexeh